When Loan Production Goals Don’t Match Market Supply

Lenders are faced with the dilemma of whether to adjust production goals up or down or keep them flat, notes Adam Seery of Harvest Small Business Finance and Harvest Commercial Capital.
Adam Seery   Image courtesy of Harvest Small Business Finance and Harvest Commercial Capital

Imagine this: You’re the president of a large ($50 billion-plus) or mid-size ($20–$50 billion) bank. The last five years have yielded year-over-year 10–15 percent loan and deposit growth. Revenue is up, losses are non-existent and shareholders are happy. The board has scheduled a meeting to discuss your strategic plan for production goals in 2020. Here are your options:

A. Increase loan production and deposit goals 10–15 percent 
B. Keep goals flat for sustained growth
C. Reduce loan production and deposit goals 10–15 percent 

What would you commit to?

If you didn’t choose “option A,” you’d be crazy. It’s been easy to accomplish year-over-year growth for the last five years. Also, when was the last time you witnessed a strategic plan where loan production projections went down? Since the recession ended, banks have had the luxury of consistent increases in inventory and loan opportunities.

The issue with choosing “option A” is it relies heavily on continued market growth and the ability to gain market share when loan inventory and deposits are currently down across the board. When the bank president commits to 10–15 percent growth, so do the bank’s employees. The negative ramifications can be substantial. A few of the repercussions when pushing unrealistic loan goals onto your team include:

Quality of credit diminishes

When deal flow is not hitting projection numbers, side conversations start happening. “How do we make that deal work?,” “Bring back that deal we passed on last week,” “Is there a way to make this fit?,” “Let’s make an exception on this one.” Banks would rather stretch on credit than not meet loan production numbers. If you believe that internal compensation is not related to production, you’ve been living under a rock. Compensation is always tied to production, even if it’s not stated publicly.

Pressure from the top hits the sales force

Again, it’s not just the executive team that sign up for a bank’s yearly production. That burden is mostly put on the sales force. If loan inventory is not there, deals will start to appear that don’t normally belong in that bank’s credit box. Now the bank is in a larger quandary: Do we approve loans outside our credit box (see No. 1 above) or do we decline loans from the sales force that we’ve asked to produce loans? Remember, sales incentives are paid on closed business. If the sales force can’t close deals, they will send those deals elsewhere and maybe start looking for new employment. 

Negative morale internally

Employee happiness comes when goals are hit and production records are being set. How does this change when production is below budget by 20 percent? That translates to daily pressure from management, rushed decisions and potential layoffs. Stress, anxiety and pressure…is that a fun place to work?

Loan losses/defaults

What’s the quickest way to lose your job in banking? Make a few bad loans. Loans in default increase the loan loss reserve to the Allowance for Loan and Lease Losses account. The additional funds used to throw into the ALLL are treated as a P&L expense, which takes away from a bank’s net income. In a downward cycle with multiple defaults, that number can grow by millions, which in turn reduces the bank’s bottom line net income by the same amount. This does not account for losses that maybe incurred from liquidation, which could add to the overall loss.

In closing, when producing loan volume estimates heading into a flat market, keep in mind the downfalls related to overstating realistic production goals. Sometimes reducing expectations can actually provide dividends to the bottom line, especially when that year-over-year expected growth was never there to begin with. It’s the long-term approach to lending that will keep banking institutions healthy moving forward.

Adam Seery is the COO of Harvest Small Business Finance and Harvest Commercial Capital, finance companies specializing in owner-user, conventional, SBA 7a and 504 loans nationwide.